Futures Exchanges, referred to herein also as an “Exchange”, such as the Chicago Mercantile Exchange Inc. (CME), provide a marketplace where future contracts and options on futures are traded. In an example, a futures contract is a standardized, legally binding agreement to buy or sell a commodity, security, financial product or other underlying instrument or investment vehicle at a specified price at a predetermined future time. The futures contract specifies commodity, quality, quantity, delivery date and settlement.
An option is the right, but not the obligation, to sell or buy an underlying instrument (in this case, a futures contract) at a specified price within a specified time. A put option on a future grants the right, but not the obligation, to sell a futures contract at the stated price prior to the expiration date and a call option gives the buyer the right, but not the obligation, to purchase a specific futures contract at a fixed price (strike price) within a specified period of time. The buyer has the right to buy the commodity (underlying futures contract) or enter a long position (e.g., a position in which the trader has bought a futures contract that does not offset a previously established short position). A call writer (seller) has the obligation to sell the commodity (or enter a short position (e.g., the opposite of a long position) at a fixed price (strike price) during a certain fixed time. The term “short” refers to one who has sold a futures contract to establish a market position, and who has not yet closed out this position through an offsetting procedure. An offset may refer to taking a second futures or options on futures position opposite to the initial or opening position (e.g., selling if one has bought, or buying if one has sold).
The Exchange may act as a “clearing house” whereby trades are confirmed, matched and settled each day until offset or delivered. The clearing house may settle trading accounts, clear trades, collect and maintain performance bond funds, regulate delivery and report trading data. The Clearing House acts as a central counterparty by which the clearing house is the buyer to each seller, and seller to each buyer, thereby protecting buyers and sellers from financial loss by assuring performance. An example of a clearing house is the Clearing House of the Chicago Mercantile Exchange (“CME”). Although the disclosed embodiments are described in reference to the CME, it all present and future embodiments are applicable to any Exchange and/or clearing house, including those which trade in equities and other securities.
The Clearing House establishes clearing level performance bonds for and establishes minimum performance bond requirements. A performance bond, also referred to as a margin, is the amount of funds that must be deposited by a trader with his or her broker, by a broker with a clearing member or by a clearing member with the Clearing House, to insure the broker or Clearing House against loss on open futures or options contracts. This performance bond is not a partial payment; rather, it acts to ensure the financial integrity of brokers, clearing members and the Exchange. The Performance Bond to Clearing House refers to the minimum dollar deposit which is required by the Clearing House from clearing members in accordance with their positions. Maintenance, or maintenance margin, refers to a sum, usually smaller than the initial performance bond, which must remain in the customer's account for any position at all times. The initial margin is the total amount of margin per contract required when a futures position is opened. A drop in funds below this level requires a deposit back to the initial margin levels. If a customer's equity in any futures position drops to or under the maintenance level because of adverse price action, the broker must issue a performance bond/margin call to restore the customer's equity. A performance bond call, also referred to as a margin call, is a demand for additional funds to bring the customer's account back up to the initial performance bond level whenever adverse price movements cause the account to go below the maintenance.
CME derives its financial stability in large part by removing debt obligations among market participants. This is accomplished by determining a settlement price at the close of the market each day for each contract and marking all open positions to that price, referred to as “mark to market.” Every contract is debited or credited based on that trading session's gains or losses. As prices move for or against a position, funds flow into and out of the trading account. Debt obligations from option contracts are also immediately removed, since the purchaser of an option must pay the premium (cost of the option) in full at the time of purchase. Sellers of options post performance bonds, discussed above, as determined by the CME according to the prevailing risk characteristics of the options sold. CME's mark-to-the-market system does not allow losses to accumulate over time or allow a market participant the opportunity to defer losses associated with market positions.
If a clearing member does not have sufficient performance bond collateral on deposit with the Clearing House, then the clearing member must meet a call for cash performance bond deposits. Clearing members' performance bond deposits may only be:                Cash (such as U.S. dollars, Canadian and Australian dollars, Japanese yen, Euro currency, Swiss francs, British pounds, Norwegian krone, and Swedish krona);        U.S. Treasury securities;        Letters of credit issued in the Exchange's name by approved banks;        Stocks selected from among approximately half of those in the S&P's 500® Stock Price Index and depository trust shares based on the S&P's 500 Stock Price Index;        Selected sovereign debt of Canada, France, Germany, and the UK;        Discount notes issued by the Federal Farm Credit Banks, Federal Home Loan Mortgage Corporation, Federal Home Loan Bank System, or Fannie Mae, provided that the notes have less than six months remaining to maturity;        Fixed rate note and bond securities issued by the Federal Farm Credit Bank, Federal Home Loan Bank, Federal Home Loan Mortgage Corporation, Fannie Mae or Ginnie Mae;        Interest Earning Facility (IEF), a CME managed fund program;        IEF2: Money Market Mutual Funds allowable under CFTC Regulation 1.25; and        IEF3 and IEF4: Clearing firm self-directed collateral management program.        
The Clearing House Division monitors intra-day price movements throughout the trading session. To assess the impact of these price changes, an intra-day mark-to-the-market calculation may be performed and reviewed by the Clearing House and Risk Management Departments several times each day, more frequently if price volatility is high. Stress testing of clearing member positions may also be performed on a daily basis. Numerous stress scenarios have been modeled to reflect a diverse universe of possible market events. Stress results are evaluated against performance bond on deposit and also with clearing member adjusted net capital. Results of stress tests may lead to requests that the clearing member provide additional information about its customer accounts such as whether there are non-CME offsetting positions in other markets. In some cases stress test results may cause increases to a clearing member's performance bond requirement, or reduce or transfer positions.
In order to minimize risk to the Exchange while minimizing the burden on members, it is desirable to approximate the requisite performance bond or margin requirement as closely as possible to the actual positions at any given time. Accuracy and flexibility of the mechanisms which estimate performance bond requirements is therefore preferred.